Elliott Wave

Basic Elliott Wave Theory and Tutorial

Elliott Wave was developed by R. N. Elliott (1938) as a way of analysing the equity markets, which tend to have a natural bullish cycle. This should be borne in mind when attempting to apply this principle to markets, which do not have the same cyclical tendencies, such as currencies and bonds. From the analytical perspective , the key is to determine the impulsive and corrective waves. Once the impulsive waves have been identified, the five wave sequence needs to be identified to provide a starting point from which to commence the analysis.

A typical wave pattern consists of five waves up in a bull markets, followed by three waves down.

The five waves up consists of three impulsive waves, 1, 3 and 5 and two corrective waves, 2 and 4. The correction following the completion of the five waves unfolds in three corrective waves, a, b and c. (See diagram below)

Each of the impulsive waves should break down into five waves of lower degree. One of the tenets of the Elliott Wave Principle is that two of the impulsive waves will tend to be of equal length, if not the relationship will tend to be 1:1.618 (key Fibonacci ratio). The corrective waves will often follow the Rule of Alternation in that if wave 2 is a simple one, wave 4 will tend to be complex, and vice versa.

The Elliott Wave relationship with Fibonacci ratios is quite strong, with corrective waves often retracing 38.2% or 61.8% of the impulsive waves. In addition, waves 2 and 4 are often related by these ratios.

Guidelines:
1) Wave 3 cannot be the shortest of the impulsive waves
2) 1 and 4 should not overlap (unless in a diagonal triangle)
3) Wave 2 and 4 should alternate (if one is complex, the other should be simple)

Corrective Waves (waves two and 4 and A-B-C) can take many forms but the most usual are:
1) 5-3-5 (Zig-Zag)
2) 3-3-5 (Flat)
3) 3-3-3-3-3 (Flat)
4) Double and triple threes (combined structures)